‘National
Income Accounts – Concepts and relevance’
Guide to Study
Objectives:
(1) Introducing the basic principles of
economic accounting and the macro-economic balances underlying the
standard approach to the estimation
national income.
(2) Understanding key concepts of Value Addition, Income, GDP,
GNP, and related national income aggregates.
(3) Understanding the relevance of national
accounting estimates for economic / social policy analysis and planning.
(4) Appreciation of the limitations of the
current system of national accounting and their implications
Structure
of presentation
(1) Introduction
(2) Fundamental
Macroeconomic accounting balance. Three approaches to estimation of domestic
production. National Accounts as a ‘System’.
(3) Selected
national accounting concepts, Value addition, Income, Domestic Product,
National Product, Constant and Current price valuations. Total and per capita
product / income concepts.
(4) Use and
relevance of national accounting estimates to economic policy analysis and
planning
(5) Limitations
of national income concepts . Why they are considered inadequate indicators of
human development.
Content
- Summary
(1) Introduction
National Accounts (NA) is a subject
concerned with estimating the total value of goods and services produced in a
country and explaining how that total is converted into incomes and shared
among the residents. The subject has been developed by combining concepts and
estimation methodology drawn from the disciplines of Economics, Accounting and
Statistics. While the origins of NA can be traced back to the work done by
British and European political economists during the second half of the 17th
Century, it was the landmark contributions made by J.M.Keynes and others during
the 1930s to develop the conceptual side of NA that laid the foundation for the
modern approach to NA. In the 1950s, the OEEC and shortly afterwards the UN
Statistical Office drew up standard sets of NA tables and proposed estimation
methods to be followed by the member countries.
(2)
Fundamental macroeconomic balance: Resources - Supply and Demand
In a modern economy, a large number of
different and individual transactions arising from man’s economic activity take
place every day. For purposes of estimation in the closed economy case, these
are classified into three broad groups: Production, Consumption and
Accumulation. When the economy has dealings with the rest of the world, that is
when the economy is open, a fourth activity – trade (that is imports and
exports) is added on. This simple classification of economic activity helps us
to formulate an accounting balance at a highly aggregative level as follows:
Table 1: Basic Accounting
Balance
Supply
|
Demand
|
Domestic
Production (Y)
|
Consumption
(C)
|
Accumulation
(I)
|
|
Imports
(M)
|
Exports
(X)
|
Total Supply (Y+M)
|
Total Demand (C+I+X)
|
This accounting balance states that the
total supply of goods and services consisting of what is produced in the
country and what is imported should be exactly equal to the total demand
consisting of Consumption, Accumulation and Exports. In symbols
Y +
M = C + I + X
This is the fundamental macro-economic
balance used as the basis for building the standard system of national
accounting.
The individual items shown in the table are not homogeneous. In the real
world, these consist of subdivisions which have to be separately estimated. We
move one step further to obtain the following disaggregation (Table 2).
(Numbers used to illustrate the accounting relationship come from the Central
Bank estimates for the year 2000.)
Table 2: Resources and
utilization: Sri Lanka
Supply
|
Demand
|
||
Domestic
Product
Agriculture 224
Industry 307
Services 594
Other (Adjstm.) 133
Imports
Goods 554
Services 69
|
1258
623
|
Consumption
Private
consumption 906
Public
consumption 132
Accumulation
Fixed capital
formation 353
Change in
stocks **
Exports
Goods 420
Services 71
|
1038
353
491
|
Total
Supply
|
1881
|
Total
Demand
|
1881
|
Domestic
Production – three approaches to estimation
Products may be classified into two main
groups: Goods and Services. In both cases, production can be regarded as a
process of value addition. This value addition is performed by combined action
of factors of production: Land, Labour
and Capital. In the advanced economies, this value addition takes place in
several stages. One way of describing the ‘Value Added’ is that it is the
difference between the value of the finished product and the material inputs
that go into its production. In the case of services, the process of value
addition may or may not involve material inputs as such, but the accounting is
basically the same.
Any given good or service has two main
types of uses: Intermediate and Final. Intermediate use occurs is mid-way in
the production process when the good is due for further processing. On the
other hand, the final use occurs when the good or service reaches the ultimate
destination – the consumer, the investor or the exporter. Making use of the
fundamental accounting relationship derived above,
Y + M = C + I +
X. ---------------(1)
If we rearrange
terms to get
Y = C + I + X –
M -----------------(2)
The second equation shows that Domestic
Production is identically equal to the sum of final uses less imports. This
relationship provides a basis for one approach to estimating the GDP. This is
called the Expenditure Method. There
are two other approaches. To illustrate the other two approaches, observe the
following chart:
CHART 1: Production and Income
Generation
Factors of Production
|
Production Process
|
Shares going to factors & Govt.
|
Appropriation by institutions
|
Material Inputs
|
|||
Land
|
VALUE ADDITION
|
Rent
to Land
|
·
Households & Individuals
·
Firms
·
Government
|
Labour
|
Wages
to Labour
|
||
Capital
|
Profit
to Capital
|
||
Indirect
Taxes to Govt
|
|||
Product
|
If we add up the Values Added (VA) in
column 2 for all goods and services we get an estimate of total production in
the economy. If we add up incomes accruing to institutions shown in column 4 in
respect of all goods produced, we get the total income arising in production.
These two have to be equal. Therefore,
the total VA in the economy is identically equal to the incomes accruing to the
3 groups of institutions.
Thus, we have three different approaches to
estimating the domestic production of a country, namely the Expenditure Method, the Production Method
and the Income Method.
National
Accounts as a system: Because of the interdependent
nature of production, income, expenditure and trade estimates, it is essential
to treat all such estimates as parts of a ‘System’. Conventionally, this system
consists of a basic (core) set of 4 interlocking accounts (tables) and a number
of detailed supporting tables. The 4 basic accounts are:
(1) Domestic
Product Account (Y)
(2) Income and
Outlay Account (C)
(3) Capital
Transactions Account (I)
(4) Balance of
Payments Account (X, M)
(3) Selected national accounting concepts
Before proceeding further, it is useful to
examine and understand a few concepts that occur frequently in national income
and its applications.
(a) Gross Domestic Product (GDP):
GDP is a measure of the total value of all goods and services produced in the
domestic economy by residents during a given period of time.
(b)
Gross National Product (GNP): GNP is a measure of
the income accruing to resident institutions of a country during a given period
of time. Such income arises from production activity taking place both within
and outside the country. Thus, GNP can be derived from GDP by adding on factor
incomes received from abroad and subtracting factor incomes paid abroad.
Thus GDP is related to production and
territory while GNP is related to incomes and residents of a country. Both are
‘Gross’ because consumption (wear and tare) of fixed capital during the
production process has not been netted out.
(c)
Real and Nominal Income: When economists talk about
income, they do not necessarily refer to a flow of money. In national income
accounting too the income of a person or an institution is actually the
quantity of goods and services that the person or institution can command
during a given period. Thus, a distinction is made between ‘real’ and ‘nominal’
income.
The annual GDP of a country changes from
year to year. If it increases in ‘real terms’, we say that the economy is experiencing
growth. The term ‘real terms’ is used to exclude that part of the increase
caused by upward shifts in the price level also called inflation. In national
income accounting, the changes in ‘Real GDP’ is estimated by using a concept
called GDP at Constant Prices. This is a number obtained by netting out price
effects. GDP estimates that include the price effects are called GDP at
‘Current Prices’. In other words, for a given year, the GDP at constant prices
and GDP at current prices represent the same aggregate but the numbers are
different because the basis of valuation is different. The increase / decrease
in GDP in constant prices is generally referred to as the growth rate of the economy.
For planners and policy makers, the growth
rate of the GDP is an important indicator. At what rate should GDP grow? In the
case of countries with growing populations, obviously the GDP should grow at a
rate higher than that of the population if the standard of living is to
improve. The comparison of the two rates leads to a very important concept
called the per-capita GDP or per capita GNP. This is simply the
Total GDP (Total GNP) divided by the number of people living in the country
during the relevant period.
(4)
Use and relevance of national accounting estimates to economic policy analysis
and planning
The study of National Accounts is important
for several reasons. The total income of a country is an indicator of its
economic power and the influence it may wield in political and strategic
affairs of the world. Furthermore, the estimates of average (per capita) income
and the distribution of the total income among various social groups - the most
important indicators of the peoples’ standard of living - form the subject
matter of many economic policy discussions. Since countries, their populations
and economies vary in size, the absolute values of most economic aggregates do
not make much sense for inter-country comparisons unless expressed as ratios of
the respective country GDP/GNP. Almost all economic analysis conducted at the
national and international levels at the present time, invariably uses such
indicators and other related national income data to a greater or lesser
degree.
The purpose of construction of national
accounts can be discussed under the following headings:
(a)
A system for presentation of
economic data
(b)
A standard for definition and
classification of statistics
(c)
A framework for analysis
(d)
A basis for formulation of
policy
(5)
National Income concepts and estimates - limitations and shortcomings
The idea that conventional national account
estimates truly represent the level of economic activity and social well being
of the people has been frequently challenged. The main issues may be summarized
as follows:
(a) The central concept in NA, the GDP does
not distinguish between production that brings benefits to society and
production that cause harm to society [The standard example of butter vs guns].
This also includes the case of by-products that cause environmental damage.
[Air, water and sound pollution]
(b) The per capita concept that is often
used in policy discussions and analysis does not take note of large disparities
in income, consumption etc within a given country or region.
(c) In the
computation of GDP, some important areas of production activity that do not
enter the market are either left out completely or inadequately covered [Well
known examples are: work done by housewives and subsistence production for own
consumption]
(d) In the case of industries concerned with
extracting non-renewable resources, no account is taken of the depletion of
stocks.
(e) In making
international comparisons using conventional country NA data, there is an
underlying assumption that a given good or service has the same utility in
every country compared. This is highly unrealistic.
Questions
(1) “Higher the
level of domestic production, higher is the level of income in the country”
Explain clearly the national accounting concept of ‘Production’ and how such
production translates into income.
(2) Sri Lanka
(3) List the three
main approaches to estimation of the GDP. Do you agree that when the economy is
open to foreign trade the country can spend more than it earns through domestic
production. Explain.
(4) Collect and
tabulate data on GNP and GNP per-capita of 6 countries. (A mix of high income
and low income countries is preferred). Rank them in terms of the size of GNP
(US Dollars Bn) and GNP per capita (US Dollars). Comment on any significant
patterns and features.
(5) Why are GDP
and GNP considered inadequate indicators of the standard of living and human
development.
(6) “Traditional
methods of National Accounting have failed to record the impacts of economic
growth on the environment”. Comment.
Further Reading
(1) UN Statistical Office: (196-) : ‘A System of
National Accounts and Supporting Tables – Studies in Methods’ Series: F No. 2
(and subsequent revisions), United
Nations , New York
(2)Richard and Giovanna Stone: (1961): ‘National
Income and Expenditure’: Bowes & Bowes, London
(3) Poul Host-Madson: (1979): ‘Macroeconomic Accounts
– An Overview’ Pamphlet Series No. 29: International Monetary Fund, Washington DC
(4) Terence Saundranayagam: (2004): ‘How to Read the
Central Bank Annual Report: DEPS, Colombo Sri Lanka
.
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